Investing: Follow the Boomers and buy health care stocks

By John Waggoner, USA TODAY

If you're a Baby Boomer, you may have noticed that your contemporaries aren't as spry as they used to be. Your favorite classic rock band's tour is being sponsored by Geritol. And everyone you knew from the Weather Underground is, well, underground.

The health care sector, include the pharmaceutical industry, has been faring well lately.

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The aging of the 77 million Boomers is one reason that the health care sector has fared so well recently. The Standard & Poor's health care index has gained 12.9% the past 12 months, vs. 2.7% for the S&P 500 with dividends reinvested. But there are other reasons to be bullish on health care, too, ranging from dividend payouts to mergers and acquisitions to the Affordable Care Act.

Let's start with the large pharmaceutical companies. For a long time, investors shunned big pharma because they faced an avalanche of patent expirations. When a patent expires, companies can no longer demand huge prices for a drug because of competition from generics, resulting in lower earnings.

No longer. "The patent expiration issue is a thing of the past," says Sam Isaly, manager of Eaton Vance Worldwide Health Sciences fund. "We have run through the bulk of the big ones, and now we're focused on what companies look like roaring out of the gate."

One of Isaly's holdings is Bristol-Meyers Squibb (BMY), which lists some 40 new drugs in exploratory development. BMY has other charms common to big drug companies: a high dividend yield and low price.

For example, BMY has an annual dividend yield of 4.3%, which looks spectacular when compared with the 10-year Treasury note, currently yielding 1.99%. The company increased its dividend modestly in December.

But decent dividends are a hallmark of large pharmaceutical companies. Abbott Labs (ABT) has a 3.5% yield, while Merck (MRK) yields 4.4%. The Boomer tie-in: Dividend-paying stocks are a big hit with retirees, and the first Boomers hit the traditional retirement age of 65 last year. (The Boomers were born from 1946 to 1964.)

And many big drug companies have low stock prices, relative to earnings, says Mark Oelschlager, manager of Live Oak Health Sciences. "You'd think they'd be drawing more interest," he says. For example, Pfizer (PFE) sells for 9.1 times its expected 2012 earnings, says Morningstar, the Chicago investment trackers. Lilly has a forward P-E of 10.6.

(Price to earnings, or P-E, measures a company's price relative to expected earnings. Lower is cheaper. The S&P 500 has a forward P-E of 12.8.)

One fertile area for new drugs is the biotechnology industry, which sometimes serves as a research and development area for the big drug companies. If a biotech company seems likely to get a promising drug through the Food and Drug Administration approval process, one of the larger companies will often buy it.

There's more to health care than drugs. Medical devices, for example, are another promising arena, says Eddie Yoon, manager of Fidelity Select Health Care fund. "Back in 1990, it cost $3 billion to sequence the human genome," Yoon says. New equipment has made it much cheaper. "Now it's more like $3,000," he says. Easier genome sequencing could lead to drugs better tailored to their users.

And the Affordable Care Act has created opportunities as well. Kris Jenner, manager of T. Rowe Price Health Sciences fund (PRHSX), says managed care companies, such as UnitedHealth Group (UNH), will benefit from the search for lowering medical costs. "No matter what the landscape, managed care companies will be part of the solution," he says.

Medical devices could also have a big role in reducing health care costs. Eventually, for example, you might be able to carry your medical history on your iPhone. In other words, someday, there might be an app for you.

Your fund may have a big slug of health care stocks already; the S&P 500 has about 11.7% in health care. If you're looking for places to invest, however, check out the next Woodstock reunion. Then put some money in health care.

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